How Charles Schwab and TD Ameritrade’s share prices reacted to its merger?

The markets were a full square behind a mooted deal between the two discount brokerage giants Charles Schwab [SCHW] and TD Ameritrade [AMTD]. Charles Schwab’s share price was down 2.18% in pre-market trading on Monday (25 November), while TD Ameritrade found its stock boosted by the news, rising 1.6% before the markets opened.

With a market cap of around $61.8bn (through 22 November), Charles Schwab share price has zoomed from a year low of around $34.96 in early October to $48.20 currently. Meanwhile, TD Ameritrade, with a market cap around $26bn, has moved from $32.59 to $48.13 the same time frame.

Charles Schwab’s $26bn offer had raised some eyebrows as it was below the $30bn market cap that TD Ameritrade held earlier this year. There were also concerns that the merger would draw the attention of regulators, considering Charles Schwab’s move to cut commissions back in October as a way to “cripple its competitors”, one of which it was then attempting to acquire at a considerable discount, The Motley Fool noted.

However, analysts believe the combination will perform strongly. Under its new free-trading structure Charles Schwab has added 142,000 new brokerage accounts to a total of 12.2 million total active brokerage accounts in October. Total client assets meanwhile climbed to $3.85tn.

Following the acquisition, the combined two firms will oversee in excess of $5tn in client assets, according to The Motley Fool.

Charles Schwab will find the larger asset base particularly valuable, as it relies heavily on interest earned from clients’ cash deposits, The Motley Fool explains. “A merger would also allow the combined company to shed costs by aligning back-office operations and technology platforms.”

“A merger would also allow the combined company to shed costs by aligning back-office operations and technology platforms” - The Motley Fool's Joe Tenebruso

Cutting commissions

Discount stock brokerages carry out buy and sell orders at reduced commission rate and do not provide investment advice or analysis. Operating mostly online, such services have grown in recent years because of their low costs and accessibility to anyone with a smartphone or laptop.

However, the sector has been in flux recently as low-interest rates reduce the profits brokers make from money nestling in customers’ accounts. In addition, last month Charles Schwab – followed by many others such as TD Ameritrade, Fidelity and E*Trade Financial Corporation [ETFC] – began offering clients zero-commission-fee trading on US equities, ETFs and options.

The surprise decision came partly in response to Vanguard cutting fees on ETFs, JP Morgan offering free trades to customers and, albeit belatedly, to the launch of free stock-trading apps like Robinhood. It is also an attempt to make investing easier and more affordable, as well as expanding the customer base of these companies. However, it has resulted in brokers sacrificing a strong revenue stream.

All the major players’ share prices took an initial hit from the shift to zero commission fees. TD Ameritrade, for example, dropped 43% from a high of around $57 back in February before recovering to around $48. Charles Schwab similarly dipped around 27% from a YTD high of around $47 but has since reached new highs for the year.

Charles Schwab & TD Ameritrade share price vitals, Yahoo Finance, 25 November 2019

The birth of a giant

Prior to Charles Schwab confirming its acquisition, the proposal had drawn support from many. “This would create a Goliath in wealth management,” Wells Fargo senior analyst Mike Mayo had previously stated in a note to clients.

"An acquisition of TD Ameritrade would expand Schwab's roster of active traders and solidify its leading position serving independent advisers," stated David Ritter, a financial analyst with Bloomberg Intelligence told Bloomberg Quint. Todd Rosenbluth, director of ETF research at CFRA Research, was also enthusiastic, telling the publication that the merger could “reduce the likelihood that investors bounce around," meaning that they would “have a go-to destination."

“An acquisition of TD Ameritrade would expand Schwab's roster of active traders and solidify its leading position serving independent advisers” - Bloomberg Intelligence financial analyst David Ritter

Other experts refused to join the bandwagon.

“The discount brokerage industry has become a very-low-margin business dependent on as wide a customer base as possible,” Mark Hulbert had written in MarketWatch. He notes that with fees at zero, Charles Schwab will now have to rely on “upselling” its premium $30 account to customers, of which it will need a huge base to upsell enough to create significant profit.

Betting on the success or otherwise of the combined group could create an opportunity, but another could be in looking for further consolidation in the sector given revenue and profit pressures and the need for synergies and client growth.

Analysts have earmarked E*Trade Financial as the most likely next acquisition target, but there could well be others such as Robinhood and Stash.

“Expect more consolidation throughout the industry,” said Michael Spellacy, a capital markets expert at Accenture, in comments to MarketWatch. “We are in the early innings.”